News & Events

Effects of RMB Revaluation September 2005 | GFIA

The most visible
effect of the recent revaluation of the RMB was
a dramatic increase in the volume of macroeconomic
ramblings from financial analysts globally, and
a rash of "special bulletins" in our
in-boxes.

Our summary is that the revaluation is at the
same time immaterial and massively significant.
It's immaterial in that it was expected, it was
small, and has few discernible short-term effects.
It's massively significant as it's the watershed
point at which the PRC begins its transition to
the world's largest economy, by engaging with
global capital markets.

Generally, the revaluation is of more immediate
political and diplomatic significance that commercial.
While it may accelerate the flow of speculative
money into the PRC in the near term, it is part
of an ongoing continuum of capital flows. It's
also not impossible that it marks a peak in the
current cycle of capital inflows ("buy on
guns, sell on trumpets").

Realistically, looking at the strength of the
Chinese economy and its exports, a 2.1% increase
is not sufficient. From an economic standpoint,
it makes sense to expect China to continue with
their revaluation process. We expect that, while
the PRC will definitely let the RMB appreciate
(although the question over what period, remains),
it will likely to be in small increments such
that the immediate impact of the adjustment will
not be significant (as they have shown with this
initial revaluation). The banded float against
a trading basket (pioneered most effectively in
Singapore) allows the Chinese central bank a good
chance of managing its currency at least expense
with least vulnerability to speculation.

However, in the near term, there are dangers.
The situation that China is facing right now is
one of "internal troubles (socio-economic
problems)" and "external threats (hot
money)", which therefore requires them to
move very carefully on the currency front. While
the Chinese economy looks strong as a whole, internally,
the Chinese government is treading a fine line
as economic robustness is disproportionately contained
within a few cities; the wider and ever-present
challenge of feeding and housing the world's most
populous nation remains. Sudden moves such as
a significant appreciation of the RMB may trigger
movements of hot money (Morgan Stanley's Andy
Xie estimates that there is currently US$700 billion
of hot money in Asia with roughly half of it in
China). There are 1.2 billion mouths to feed in
this country; the repercussions of an exodus of
hot money taking profits, on the Chinese domestic
economy, would be hugely negative. One other reason
why the Chinese will move very slowly is also
because of the number of hedge and other investment
funds that have set up to play the China-story
(at least 11 new China-themed hedge funds have
emerged over the past 12 months. That's roughly
one new China fund per month. 20 years of experience
in investment, most of it in emerging markets,
tells us that a rash of me-too fund launches is
a sure prelude to a mess. Be afraid…be very
afraid!)

With the removal of the currency pegs on the
RMB and MYR, the US$ may be in for a downward
trip since both China (and inevitably Malaysia,
and probably the majority of Asian countries)
will decreasingly be buyers of massive amounts
of US$ sovereign debt. In fact, they need to diversify
out of their existing holdings. Looking
at the Bank of Korea's stance, one would expect
them too to start shedding some of their US$ holdings
following this revaluation and other Asian countries
are also likely to follow suit.

So what does the revaluation mean for Asian hedge
funds? In its simplest form, China-themed hedge
funds investing in Chinese companies will probably
benefit from the appreciation. Assuming that there
is no hedging in the portfolios, then 2.1% of
this month's gain in the long book should be due
to the appreciation of the RMB against the US$.
We can also expect investors and speculators to
continue to invest in Chinese equities (both China
and foreign-listed) in the short term thereby
creating a positive upward momentum. Overall,
we think that Asian hedge funds stand to gain
as the other Asian currencies allow themselves
to strengthen against the US$ whereas they were
previously kept artificially depressed because
of the MYR and RMB pegs. Looking forward, we'll
have to take rather more note that we have done
historically, of the currency positioning of the
managers we follow.

Economically, the revaluation may not affect
most Chinese industries except perhaps some exporters
operating on thin margins. Looking at many of
the key holdings of the long-short equity hedge
funds, thin margins may be one criterion when
choosing potential candidates for shorts (so may
be a source of profit but conversely would not
have been likely grounds for a long purchase).
We doubt there will be a great deal of net effect
on underlying valuations and corporate prospects.
However industries that were in the danger of
facing protectionist actions by importing countries
are less at risk, although we expect these complaints
to resurface regularly over the next decade. A
more immediate result may be that bullish foreign
investors bid up the prices of the better known
stocks, regardless of fundamentals.

The manager interview shown on this page is for viewing by accredited investors only. By providing your consent, you agree that you are an accredited investor and will not use the following content for marketing purposes.